Legal Reform Turns a Steward Into an Activist

By KAREN DONOVAN

Published: April 16, 2005

CORRECTION APPENDED

After J.P. Morgan agreed to pay a $2 billion settlement in the WorldCom case last month, the New York state comptroller, Alan G. Hevesi, had this to say to a scrum of reporters waiting outside the federal courthouse in Lower Manhattan: ''I'm trying to sound like a lawyer; I'm not a lawyer.''

To some, that is precisely the problem.

Mr. Hevesi is the sole fiduciary for the $120 billion New York State Common Retirement Fund. As steward of the fund, he has been acting a lot like the sort of activist lawyer that Congress tried to put out of business in 1995 when it passed the Private Securities Litigation Reform Act.

But Mr. Hevesi is rewriting the legal playbook. Not only did he wrest from WorldCom's investment banks a $6 billion settlement for investors -- a record amount -- he also forced the company's former directors to pay $24.5 million out of their own pockets. Until now, directors expected their liability to be covered entirely by insurance. At the same time, Mr. Hevesi has ruffled the legal community by seeking to reduce the fees that lawyers charge, leaving investors with a higher percentage of the total settlement.

Mr. Hevesi is not the only politician taking advantage of the Public Securities Litigation Reform Act, but he is certainly one of the most prominent. The law, passed over the veto of President Bill Clinton, gave institutional investors like public pension funds the lead role in investor class-action suits. High-technology companies, the lobby group that pressed hardest for the law, had complained about frivolous lawsuits and abusive tactics practiced by the law firms that specialize in such suits.

Advocates of change in Congress were also looking to curb lawyer-driven litigation. Previously, the law firm that was first to file a class-action suit controlled the case, and with it millions of dollars in legal fees taken as a percentage of the settlement amount. Firms raced to the courthouse with lawsuits on behalf of investors who owned a tiny number of shares, seeking to represent the entire class of shareholders harmed. The law firms -- chief among them Milberg, Weiss, Bershad, Hynes & Lerach, based in New York -- lined up clients, some of whose names appeared repeatedly on lawsuits.

To address that concern, the law's authors, including Robert J. Giuffra Jr., chief counsel of the Senate Banking Committee, reasoned that because institutional investors suffered the greatest losses from corporate wrongdoing, they had the greatest interest in the outcome of securities cases, and therefore should have the lead role. Big investors would not be easily used by hungry lawyers, so the thinking went, and would not bother suing unless a case had merit.

Corporate lobbyists did not focus on this part of the law. There was no Senate debate about the idea of requiring institutional lead plaintiffs, says Mr. Giuffra, now a partner at Sullivan & Cromwell of New York. ''It happened so quickly.''

The result is that the law has succeeded in displacing some -- but not all -- ambitious lawyers as the force behind class-action suits. In their place, however, it has encouraged even more ambitious elected officials to step forward as lead plaintiffs.

No elected official seems more emboldened than Mr. Hevesi, who won statewide office in 2002. He was the lead plaintiff in a case against Raytheon that was settled for $410 million last year. He also has the lead role in a pending case against Bayer, accusing the German pharmaceutical giant of misleading investors by making false statements about the cholesterol drug Baycol. But the most significant case is his effort to recover money lost in the $11 billion fraud at WorldCom, the largest corporate accounting scandal in United States history.

Philip Angelides, the treasurer of California, has also become a vocal advocate for shareholder issues as a board member of the California Public Employees' Retirement System, or Calpers, the nation's largest public pension fund with more than $160 billion in assets. While Calpers has been less active than the New York fund, it is a co-lead plaintiff in a suit that accuses the New York Stock Exchange and its seven specialist trading firms of shortchanging investors by at least $150 million by intervening in trades where no specialist was needed. On Tuesday, without admitting or denying guilt, the New York exchange settled Securities and Exchange Commission charges that it failed to supervise floor specialists.

Still, plaintiffs' law firms that once rushed to the court have adapted to the new landscape. They quickly send out e-mail messages to pension funds when companies announce bad news. Calpers has hired Lerach, Coughlin, Stoia & Robbins, based in San Diego, for the New York exchange case. Its senior partner, William S. Lerach, was one of the lawyers Congress was hoping to put out of business. Mr. Lerach also represents the lead plaintiff, the University of California Regents, in the pending Enron class-action case.

Last year, Mr. Lerach ended his 27-year relationship with Milberg, Weiss. Now renamed Milberg, Weiss, Bershad & Shulman, the law firm was the victor on April 6 when a federal judge in New Jersey denied Mr. Hevesi's bid to take over the lead plaintiff role in a class action alleging that Merck failed to disclose the risks of the painkiller Vioxx. That leaves the New York fund, which lost $171 million on Merck stock, on the sidelines in the blockbuster case. The New York fund, however, has been lead plaintiff in four of the five largest investor class actions since 1996. Several of them were begun by Mr. Hevesi's predecessor, H. Carl McCall. In January, Mr. Hevesi announced a $960 million settlement against McKesson, the nation's largest drug distributor, based on accounting fraud at HBOC, a health care software company that it bought in 1999 -- a case he inherited from Mr. McCall.

Correction: April 19, 2005, Tuesday
A chart in Business Day on Saturday comparing the size of legal fees for investor class-action lawsuits before and after the passage of the Private Securities Litigation Reform Act of 1995 misstated the name of a bank involved in one settlement. It was the First Republicbank Corporation in Texas, not the First Republic Bank in San Francisco. The chart also misidentified the lead counsel in the Waste Management settlement. It was Goodkind Labaton Rudoff & Sucharow, not Milberg Weiss Bershad & Shulman.